ANIELA KOZIARA, ET AL., PETITIONERS V. COMMISSIONER OF INTERNAL
REVENUE
No. 87-1963
In the Supreme Court of the United States
October Term, 1988
On Petition for a Writ of Certiorari to the United States Court of
Appeals for the Sixth Circuit
Memorandum for the Respondent in Opposition
Petitioners contend that royalty payments received by them pursuant
to a unitization order entered without their consent constitute
proceeds of an involuntary conversion of their property under Section
1231 of the Internal Revenue Code, /1/ and therefore are taxable as
capital gains, rather than ordinary income.
1. Petitioners Aniela Koziara and her son, Eugene, jointly owned
three tracts of land overlying a portion of a large reservoir of oil
and gas in St. Clair County, Michigan known as the Columbus 3 Pool.
/2/ Two of these tracts contained producing wells and were held
subject to leases that conveyed to others the right to develop and
produce oil and gas, but reserved to petitioners royalty interests in
the oil and gas produced. Pet. App. B3-B4, E2-E4.
In 1974, the Michigan Supervisor of Wells approved a unitization
plan for the Columbus 3 Pool that had been proposed by Sun Oil
Company, which already held the working interest on the largest of
petitioners' tracts. Unitization permits an entire field to be
operated as a single unit without regard to surface boundary lines and
is designed to increase the total recovery of oil and gas from the
field. When a field is unitized, the owners of tracts within the
field receive royalties on a fraction of the production of the field
as a whole, rather than on the production of their individual tracts.
See id. at B5, E3-E7. Petitioners, whose interest was determined to
be 17.33183% of the entire field, voted against unitization (see id.
at E7). The Supervisor of Wells found, however, that the unitization
plan had been approved by the owners entitled to receive at least 75%
of the royalties, as required by Mich. Comp. Laws Ann. Section 319.357
(West 1984), and the plan went into effect (id. at B7, E7, F1-F3).
/3/
Petitioners received royalty payments in 1975, 1976, and 1977 on
the oil produced from the Columbus 3 Pool, according to the allocation
provided in the unitization plan. Petitioners originally reported the
payments received by them in 1975 and 1976 as ordinary income on their
federal income tax returns. They treated the payments received by
them in 1977 as capital gains, however, on the theory that the
payments constituted proceeds of an "involuntary conversion" of their
property as a result of "an exercise of the power of requisition or
condemnation," within the meaning of Section 1231 of the Code.
Thereafter, petitioners filed amended returns for 1975 and 1976
claiming capital gain treatment for the payments received in those
years under the same theory. Pet. App. B7-B8.
On audit, the Commissioner concluded that the royalty payments
received by petitioners were taxable as ordinary income, and
accordingly determined a deficiency. Petitioners then sought review
in the Tax Court, which upheld the Commissioner's determination that
the royalty payments were taxable as ordinary income (Pet. App.
B1-B14). The court stated that the term "requisition or condemnation"
in Section 1231 refers to an exercise of the power of eminent domain
(id. at B11), and that the purpose of the Michigan unitization statute
is to regulate the extraction of oil and gas so that the interests of
all parties "will be protected -- not taken away" (id. at B12). The
court concluded that "(t)he Michigan unitization procedure represents
a regulation of the extraction process to avoid (one landowner's
operating to the detriment of others), not the exercise of the power
of eminent domain, nor does it constitute an involuntary conversion of
property interests of the affected parties" (id. at B12-B13).
Accordingly, the Tax Court held that there was no involuntary
conversion of petitioners' property under Section 1231 and therefore
no basis for capital gain treatment of the royalty payments (id. at
B13-B14). The court of appeals affirmed "upon the opinion of the Tax
Court" (id. at A1).
2. The decision below is correct and does not conflict with any
decision of this Court or of another court of appeals. There is
accordingly no reason for review by this Court.
It is undisputed that royalty payments are taxable as ordinary
income, subject to a depletion allowance, rather than as capital gain.
See Burnet v. Harmel, 287 U.S. 103 (1932). Petitioners rely on
Section 1231 of the Code, which permits proceeds of an "involuntary
conversion" of property used in a trade or business or of capital
assets to be treated as capital gains, but the courts below correctly
held that Section 1231 has no application here. The purpose of the
unitization order was to regulate the extraction of oil and gas from
the Columbus 3 Pool and to determine the allocation of the proceeds,
not to take the property of any owner for public use. Petitioners
retained title to their land and to the oil and gas under their land,
and they continued to receive royalties on their share of the
production of the field. See Pet. App. B12. From petitioners'
perspective, the only change was in the manner in which the royalties
were calculated, specifically, the fact that unitization yielded
computation of the royalties based on the production of the field as a
whole, with an allocation to each tract, instead of determining the
amount directly produced by each tract. /4/
Petitioners argue that the unitization plan, while not a direct
condemnation by the state, was a form of "inverse condemnation" (Pet.
19-20). The premise of petitioners' argument appears to be that the
royalties that they receive under the unitization plan are too small
because one of the largest parts of the field is located under their
tracts. Whatever the merit of that argument -- and it was presented
to the Michigan courts (see Pet. 12 & n.8) -- it has no bearing on the
tax treatment of the royalty payments at issue here. Plainly, the
claim that petitioners should have received more royalties provides no
basis for disputing the ordinary income character of the royalty
payments that they did receive, which were based on the allocation
between petitioners' royalty interests and the working interests that
had been agreed to in the leases (see note 4, supra). Those royalty
payments were ordinary income when received by petitioners under the
leases, and they remained ordinary income when received pursuant to
the unitization plan. Cf. Commissioner v. Gillette Motor Co., 364
U.S. 130 (1960) (payments for fair rental value of business seized and
operated by government during the war was ordinary income, not gain
from "involuntary conversion"). /5/
It is therefore respectfully submitted that the petition for a writ
of certiorari should be denied.
CHARLES FRIED
Solicitor General
JULY 1988
/1/ Unless otherwise noted, all statutory references are to the
Internal Revenue Code of 1954 (26 U.S.C.), as amended (the Code).
/2/ Laura Koziara is a party solely by virtue of having filed joint
income tax returns with her husband, Eugune Koziara. For convenience,
we will use the term "petitioners" to refer to Aniela Koziara and
Eugene Koziara, who are the parties who received the royalty payments.
/3/ Petitioners challenged the unitization order by means of an
administrative appeal and, when that was denied, through a lawsuit in
state court. Their basic challenge to implementation of the plan was
rejected, but the Michigan Court of Appeals did remand the case to the
circuit court to provide petitioners an opportunity to show that their
royalty interest under the unitization plan should be increased. See
Pet. App. B6-B7; Wronski v. Sun Oil Co., 108 Mich. App. 178, 310
N.W.2d 321 (1981).
/4/ The unitization plan allocated the production among the various
tracts in accordance with a formula that reflected the amounts of oil
and gas contained in each tract and the amount of oil produced from
each tract during the fourth quarter of 1971. Pet. App. E7-E8. The
production allocated to each tract was then distributed among the
parties having an interest in that particular tract "in the same
manner, in the same proportions, and upon the same conditions" as if
the unitization agreement had not been entered into (id. at G9). In
other words, once the portion of the total production was allocated to
petitioners' tracts, they received the royalty percentage that they
had negotiated in their leases (see id. at E15).
/5/ Petitioners' reliance (Pet. 30) on Rev. Rul. 68-226, 1968-1
C.B. 362, is misplaced. That ruling involved the sale by a lessee of
his entire leasehold interest (or an undivided portion thereof) in oil
an gas in place, not royalty payments based on the extraction of a
specific amount of the minerals in place.